An exchange offer is an offer by an entity to exchange one security for another security according to an exchange ratio. In such offers, for example, a party holding a first security may offer units of the first security to investors holding a second security in exchange for units of the second security, where the number of units of the first security the investors receive in the exchange is based on the exchange ratio. Typically, the investors have a tender period over which to decide whether to submit some or all of their securities for exchange, and some or all of the tendered securities may be accepted in the offer by the offering party.
Exchange offers using a fixed exchange ratio that is established at the inception of the tender period are known. For example, a first party may offer one unit of a first security for two units of the second security, such that the ratio of the first security to the second security is always one to two. Typically, for legal and other reasons, there is a minimum amount of time given to investors to consider the exchange offer (e.g., 20 business days). Typically, the fixed exchange ratio would provide the holders of the second security an economic incentive to participate in the exchange offer. For example, assuming at inception, or immediately prior thereto, the first security is valued at $100/share and the second security at $50/share. The first party may offer to exchange one unit of the first security for every 1.8 units of the second security, thereby providing a discount of $10/unit of the first security exchanged. In such fixed-ratio offers, the return to investors depends on the value at offer expiration of both what is offered (e.g., first security) and what is tendered (e.g., second security). Sophisticated investors may seek to lock in the discount at the offer's inception through a variety of trading strategies (such as a long-short arbitrage strategy) that, when implemented, could make them economically indifferent to subsequent changes in the trading price for the securities involved over the tender period. Less sophisticated investors may not pursue such trading strategies. As a result, their participation decision may be more heavily influenced by the relative prices of each security at the offer's end, which may not reflect the discount originally provided.
For various reasons, including to mitigate disadvantages of fixed-ratio offers and to permit a more current market valuation of the securities involved in the exchange, exchange offers have been employed in the past where the exchange ratio was based on a formula using trading data over a specified time period (e.g., ten trading days). In such offerings, however, the final exchange ratio was required to be set two or more full trading days preceding the offer expiration. In such formula-based exchange ratios, the exchange ratio is sometimes based on the volume-weighted average trading price (“VWAP”) of the securities involved.
While such formula-based exchange ratios provide benefits to traditional fixed-ratio offers, the values of the securities involved may still fluctuate without limit during the trading interval after the exchange ratio is set but before the offer expires. During that trading interval, sophisticated investors may take steps, as they might do in traditional fixed-ratio offers, to lock in the value embedded in the exchange ratio, whereas less sophisticated investors may lack the know-how or means to do the same.